The Huntsman Alternative

By Simon Johnson

The eurozone financial situation continues to worsen.  The latest idea from the eurogroup of finance ministers is apparently to have the European Central Bank make a massive loan to the International Monetary Fund, which would then turn around and lend to countries like Italy.  This is a bizarre notion.  If the IMF takes the credit risk of a mega-loan to Italy – e.g., an amount around the $600 billion mark, greater than the fund's current lending capacity – this would represent an unprecedented and unacceptable risk to the IMF's shareholders, including U.S. taxpayers.  If the IMF does not take this credit risk, what's the point?  The ECB should provide financial support directly to Italy, if that is the goal.

But that goal increasingly seems both to be the only idea of officials and the last failed notion of a fading era.  More bailouts and the reinforcement of moral hazard – protecting bankers and other creditors against the downside of their mistakes – is the last thing that the world's financial system needs.   Yet this is also the main idea of the Obama administration.  Treasury Secretary Tim Geithner told the Fiscal Times this week that European leaders "are going to have to move more quickly to put in place a strong firewall to help protect countries that are undertaking reforms," meaning more bailouts.  And this week we learned more about the underhand and undemocratic ways in which the Federal Reserve saved big banks last time around.  (You should read Ron Suskind's book, Confidence Men: Wall Street, Washington, and the Education of a President, to understand Mr. Geithner's philosophy of unconditional bailouts; remember that he was president of the New York Fed before become treasury secretary.)

Is there really no alternative to pouring good money after bad?

In a policy statement released this week, Governor Jon Huntsman articulates a coherent alternative approach to the financial sector, which begins with a diagnosis of our current problem: Too Big To Fail banks,

"To protect taxpayers from future bailouts and stabilize America's economic foundation, Jon Huntsman will end too-big-to-fail. Today we can already begin to see the outlines of the next financial crisis and bailouts. More than three years after the crisis and the accompanying bailouts, the six largest U.S. financial institutions are significantly bigger than they were before the crisis, having been encouraged by regulators to snap up Bear Stearns and other competitors at bargain prices"

Mr. Geithner feared the collapse of big banks in 2008-09 – but his policies have made them bigger.  This makes no sense.  Every opportunity should be taken to make the megabanks smaller and there are plenty of tools available, including hard size caps and a punitive tax on excessive size and leverage (with any proceeds from this tax being used to reduce the tax burden on the nonfinancial sector, which will otherwise be crushed by the big banks' continued dangerous behavior).

The goal is simple, as Mr. Huntsman said in his recent Wall Street Journal opinion piece: make the banks small enough and simple enough to fail, "Hedge funds and private equity funds go out of business all the time when they make big mistakes, to the notice of few, because they are not too big to fail. There is no reason why banks cannot live with the same reality."

The path we are on leads to more state ownership of banks in Europe – not a good idea – and, in the United States, huge open-ended subsidies to private banks.  Executives in those banks get the upside and American taxpayers and workers get the downside – a huge recession, damage to millions of lives, and a huge run-up in government debt due to lost tax revenue.

Everything else Mr. Huntsman wants is also eminently sensible, including full transparency in the derivatives market.  Who will argue with that proposal as we watch the European financial sector spiral downwards – driven partly by the fear of what lurks in prominent opaque transactions and balance sheets?

Mr. Huntsman has also spotted the fatal flaw in Basel III: "The Basel III Accord primes the pump for the next financial crisis by putting its thumb on the scale of sovereign debt, making it less expensive for banks to invest in those instruments without making a realistic risk assessment."  Again, in the light of recent developments in Europe, who can seriously dispute this?

These are not fringe or unproven ideas.  When I talk with sensible people in and around the financial sector, these are exactly their views.  These are also natural Republican ideas – what we have now is not a market, it's a huge, unfair, and dangerous subsidy scheme.  Such points are made by top academics like Gene Fama (University of Chicago) and Alan Meltzer (Carnegie Mellon), former officials such as Nicolas Brady and George Schultz (both former treasury secretaries), as well as by top Federal Reserve officials, like Richard Fisher (president of the Dallas Fed) and Tom Hoenig (recently retired from being president of the Kansas City Fed; nominated to become the number two person at the FDIC).  (See my coverage of this strong current of Republican thinking in past Economix columns, including these two.)

Only Teddy Roosevelt could take on the industrial and railroad monopolies in 1901, only Richard Nixon could go to China in 1972, and only Jon Huntsman can face down the Too Big To Fail banks today.

An edited version of this post appeared this morning on the NYT.com's Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.